The constant cycle of interest rate cuts is posing a huge challenge for banks in their aim to sustain high profit growth.
On October 8, the People's Bank of China cut both lending and deposit rates. The one-year benchmark lending rate dropped to 6.93 percent and the one-year deposit rate is now 3.87 percent.
This is the second time in a month that China's central bank announced interest rate cuts. On September 16, lending rates were cut for the first time in six years.
"The second rate cut in one month resulted in a combined drop of 36 to 64 basis points on interest rate," said Qiu Zhicheng, a Haitong Securities Co analyst. "The big lending cut aimed to reduce corporate cost of enterprises and encourage investments."
This was good news for companies struggling on the brink of collapse due to lack of liquidity and poor demand from the West, which is bracing for a chilly economic winter.
However, the cycle of rate cuts does not bode well for lenders, who are alarmed by the narrowing of their interest spread.
"The latest rate cut makes the slowdown of the banking industry seem more and more probable," said Qiu.
The central bank has left current account deposit rates unchanged this time while all lending rates were marked down. This decision severely squeezed the interest spread of banks.
Traditional income from interest rate spread still forms a major portion of the profit pie of Chinese banks.
For instance, Industrial and Commercial Bank of China, the country's biggest lender, reported an interest income of 131.79 billion yuan (US$20 billion) in the first half, up 29 percent from a year ago. This was the largest income among the country's 14 listed banks on the Chinese mainland.
In its latest policy package, the central bank also said it will ratchet down the reserve requirement - the amount banks must keep on hand - to 16 percent this week for joint stock banks and small players. The requirement will also be scaled down to 17 percent for the country's big five state owned banks - ICBC, Bank of China, Agricultural Bank of China, China Construction Bank and Bank of Communications.